Whilst one of these land sales completed in line with the board's expectations, the second (and notably the larger of the two) was planned to be made up of three separate parcels across the next three years ending 31 December 2018. However, the site has now been sold in two parts, completing this year and next, and the total profit on disposal is “materially higher than had previously been anticipated”.
This is good news because, irrespective of which way the UK public votes in the forthcoming EU referendum, the latest guidance from the company’s senior management led by chief executive John Sutcliffe indicates that results for the full-year to end-December 2016 will be “comfortably ahead of market expectations”. As a result, analysts at broking houses Numis Securities, WH Ireland and Investec Securities each raised their earnings estimates by around 10 per cent with the new pre-tax profit consensus estimate of £37.6m representing a 16 per cent increase on profits in 2015. On this basis, expect EPS of about 21p, up from 17.2p in 2015, and a hike in the dividend per share from 6.1p to a range between 6.5p to 7p. This means Henry Boot’s shares are priced on a modest 10.5 times earnings estimates and offer a prospective dividend yield of 3 per cent plus.
Seriously undervalued
One of the reasons why the shares have been subdued this year, and have barely moved since I last rated them a buy in early February around the current price level (‘Playing the housing market’, 3 February 2016), is down to transactional uncertainty ahead of the forthcoming EU referendum and concerns over the impact on business resulting from a Brexit. The doom and gloom scenario for the UK housing market in the event of a Brexit, as portrayed by prime minister David Cameron and Chancellor George Osborne, is hardly likely to boost investor sentiment short-term even if it transpires to be more fiction than fact. The point is that there is a significant Brexit risk premium embedded into Henry Boot’s current valuation and one that we can realistically expect to unwind sharply in the event of a remain vote.
To put this ‘hidden value’ into some perspective, a sum-of-the-parts valuation of the company indicates that the value embedded in Hallam Land, Henry Boot's residential land development arm, is worth as much as the company’s market value alone. In total, the company has 27,653 plots across 1,804 acres of owned land and 9,257 acres of agency or under option land, according to analysts at Investec Securities.
Assuming a 50 per cent success rate at the planning stage, and 10 plots per acre, Investec estimate an average plot value of £43,000 on which the company will make an operating margin of 70 per cent on owned land bank, and 15 per cent on optioned and agency sites, after factoring in all planning costs. Based on the realistic assumption that the land bank takes a decade to sell down, then the company can expect to generate an annual operating profit of £28.5m on the land bank as it unwinds. It will also recoup the £139m cost of the land stated in its balance sheet. In other words, no matter which way I look at it it’s really not difficult to derive a value of circa £300m for the company’s land holdings using sensible discounted cash flow models. Henry Boot’s market value is £291m based on a 220p share price and net borrowings of £38m at the end of 2015.
I would also flag up that the above assumptions could prove conservative. That’s because since December 2015 the company has obtained planning permission on five sites for over 3,400 homes, has a further 52 sites for sale with over 15,000 units and there are an additional 29 sites, with potential for over 13,000 units, either at appeal or as yet undetermined planning applications. I would flag up too that the board have approval for 30 new sites across 2,000 acres to replenish the portfolio, so offering potential for further value creation. The two aforementioned land sales of 275 units aside, the company concluded four other sales totalling 450 plots in the first five months of the current financial year and I understand Henry Boot’s management is “in detailed discussions on ten other schemes, the majority of which should complete before the December year-end”.
It doesn’t take a genius to realise that the pent up demand from housebuilders, some of which have adopted a conservative stance in their land buying activities in the run up to the EU Referendum, is likely to be released if the UK public vote to stay in the EU. And because all the concluded land disposals in the first half of this year will underpin Henry Boot’s full-year performance, then there is scope for further upgrades as the year progresses if transactional activity returns to normal post the EU referendum. I remain of the opinion that the financial betting exchanges have priced up the vote correctly with the current odds suggesting only a 27 per cent chance of a Brexit. Around £21m has been wagered on the outcome of the vote on Betfair’s betting exchange alone.
Hot property
I also feel that investors are failing to see the value creation in Henry Boot’s commercial property development business. This unit is on course to develop projects worth £500m of gross development value over the next four years, and not speculative ones either: 90 per cent have been pre-sold, and almost all have been pre-let.
For instance, the company is developing over one million sq ft of distribution space at Markham Vale, a 200 acre business park being developed in partnership with Derbyshire County Council. This follows the exchange of contracts for a 225,000 sq ft bespoke unit and agreement of terms for a further 480,000 sq ft of warehousing, in addition to the 480,000 sq ft of space already pre-let to Great Bear Distribution. These three schemes, which are all forward funded or pre-sold, are expected to complete in late 2016 or early 2017. The industrial warehouse has a gross development value of £35m and Henry Boot should make a 10 per cent profit margin, accounting for 9 per cent of current year profit estimates.
Another project is the conversion of the former Terry’s Chocolate Factory in York, a 170,000 sq ft listed building, into 150 luxury apartments. The development opened in April and by the end of May had already taken 40 reservations with the first sales due for completion in the second half of this year. Residential developer PJ Livesey is converting the building into apartments and the former head office on the site has been pre-sold to Springfield Healthcare Group. By my reckoning these two deals have a gross development value of £40m of which Henry Boot could make development profits of £10m, so underpinning around 13 per cent of group pre-tax profit estimates for its 2016 and 2017 financial years.
I would also flag up a potential £30m gross development profit to be earned over the next three years on phase one of the new 850,000 sq ft Aberdeen Exhibition and Conference Centre, full details of which I discussed previously ('A six shooter of small cap buys', 10 March 2015). Work on the first phase is scheduled to start in the second half of this year.
Sum-of-the-parts valuations
The point is that the book value of Henry Boot’s profitable commercial property development projects is £132m, or 100p a share. But that in itself doesn’t tell the full story of the value on offer here given that the company also has a profitable construction business which made £8.9m operating profit last year; own a 61 per cent interest in a PFI road project - the A69 trunk road between Newcastle and Carlisle - which has another 10 years to run and which generates a net operating after tax profit of £2.9m a year; and owns a plant hire business too. Analysts value these three business at north of £50m in total, or around 38p a share.
So after accounting for central overheads and modest group net debt of £38m – equating to balance sheet gearing of 17 per cent on a conservative book value – then sum-of-the-parts valuations approaching £395m, a sum worth 300p a share, is not an unreasonable valuation once you factor in the solid revenue streams the company is generating from commercial development projects, the value embedded in its property investment portfolio, and the hidden value in its land bank.
The bottom line is that a vote in favour to stay in the EU could see a sharp rerating of the shares which is one reason why I continue to rate them a value buy on a bid-offer spread of 216p to 220p. My upgraded target price is 280p (up from 260p), ahead of the 264p target of analysts at Numis Securities, but well below the 317p target of WH Ireland and the 294p target of Investec Securities. Buy.
